Cameron Izadi

Personal Financial and Informational Blog

2011 Multifamily Housing Market Outlook – Southern California

Multifamily housing demand improved during 2010, with increased occupancy rates for all Southern California metro areas. Orange County, San Diego County, and the Inland Empire experienced higher levels of positive net absorption than in 2009. Vacancies and rents in all four markets are expected to remain relatively stable to slightly increasing/decreasing, varying from submarket to submarket.

Job Growth
Job losses have stopped in Los Angeles County, which added 2,500 jobs in 2010. The region is also expected to create 25,000 to 35,000 new jobs in the coming year. In 2010, Orange County gained 6,500 new jobs, seeing a decline in the unemployment rate from 9.5 to 8.9 percent, the lowest of the four markets. San Diego added 5,200 jobs in 2010, bringing its unemployment rate down to 10.1 percent, the second lowest of the four markets. However, little to no significant job growth is expected in 2011 for the region. The Inland Empire suffered a major blow from the economic recession, registering one of the highest foreclosure rates in the country, along with heavy job losses. Riverside-San Bernardino area lost 7,600 jobs in 2010, ending with an unemployment rate of 14 percent, the highest in Southern California. The Inland Empire is expected to experience some job growth throughout 2011, adding as many as 9,000 jobs (primarily from companies seeking lower rental costs moving warehousing and distribution operations to the area), an 80 basis point reduction to the 2010 regional unemployment rate.

Rent & Vacancy
Los Angeles County gained 2,500 jobs in 2010, a significant improvement from its 225,000 job loss the prior year. Positive net absorption in the region was only 28 percent the level observed in 2009. Despite an improvement in apartment demand, vacancy rates are still 1 to 3 percentage points above  their “natural” level (the level at which inflation-adjusted rents remain constant). Intown Los Angeles showed the largest increase in average rents (6.8 percent), followed by the South Bay submarket (5.9%). Tri Cities showed the largest decline (9.2 percent), and was one of only two submarkets with larger declines in average rents for 2010 relative to 2009. Completions for 2011 will decline roughly 60 percent from 2010 levels.

Orange County’s job market experienced some degree of stabilization by adding 6,500 jobs in 2010 (following a 75,000 job loss in 2009). Demand for apartments in Q4 2010 with a YoY positive net absorption of 5,830 units, a 39 percent increase for the period. Occupancy increased another 1.2 percent during the same period, bringing the overall rate to 94.9 percent. Average rents rose 0.8 percent in 2010, bringing the monthly rent for 2010 to $1,475. While the County added 3,187 new units in 2010, of which the Irvine submarket alone accounted for 60 percent, completions for 2011 are expected to drop dramatically, with North Orange County, Anaheim, and Huntington Beach adding only 176 new units.

Multifamily housing markets in the Inland Empire have been severely affected by the economic recession. Unemployment rates in Riverside and San Bernardino have been as high as 14.9 and 13.8 percent, respectively, in 2009. By December 2010 these rates saw little improvement, having stood at a combined 14 percent for the two counties. The region lost 7,600 jobs in 2010. However, like Orange County, demand for apartments increased in 2010 at a net absorption rate of 4,280 units, a 15 percent YoY increase. Average rents increased 1.1 percent, ending the 2010 year at a monthly figure of $1,034. Although 2,068 new units were added in 2010, like Orange County, completions are expected to drop precipitously in 2011, with just over 200 units scheduled for delivery between the East San Bernardino, Southwest Riverside, and Coachella Valley submarkets. Considering the anticipated employment turnaround, this low level of development could serve to place some upward pressure on rents and decrease vacancies in the area.

San Diego County’s unemployment rate fell to 10.1 percent, the second lowest of the four markets. The region added 5,200 jobs in 2010, rebounding from a job loss of 43,000 in 2009. Apartment demand continued its upward trend from 2009, with 3,420 units of positive net absorption. Although net move-ins were 82 percent higher than the prior year, the region had the lowest absolute level of net absorption among the four markets. San Diego County also had the second worst relative change in demand for 2010. However, occupancy increased 0.3 percent to 95.4 percent, which is the highest level of all four markets. The region added 2,616 units in 2010, up nearly 1,000 units from 2009. Intown/Coronado, Chula Vista/Imperial Beach, and Escondido will add 1,051 new units in 2011.

For the first time in two years, all four markets saw a turnaround in rent growth in 2010. All four markets experienced YoY effective rent increases, as well as falling average vacancy rates. Over the next two years, average rents are expected to remain stable, as vacancy rates will appear stable-to-declining across all four markets.

Although positive rent growth was recorded in Los Angeles County in 2010, rents trended downward from March onward. Modest further decline is expected. Average rents and vacancy rates for Orange County, San Diego County, and the Inland Empire are forecasted to remain relatively flat-to-slightly-increasing over the next eight quarters. Vacancy is expected to decline another half percent in Los Angeles County, while only slightly in San Diego County and the Inland Empire. Orange County’s vacancy rates are expected to remain stable. Currently, all four markets are still 1 to 3 percentage points above their natural vacancy rates.

Competition from shadow market inventory is expected to decline further in 2011, as it is believed to have done in 2010. This, in conjunction with a small increase in supply from construction activity, will work to increase rents and decrease vacancies in all four markets. Rising oil prices may also work to move demand away from farther-flung submarkets, such as the Antelope Valley of Los Angeles, and towards economic centers as residents move closer to their workplaces to lower the cost of their daily commute.

1) 2011 Casden Real Estate Multifamily Market Forecast, University of Southern California
2) Marcus & Millichap Apartment Research Market Update – Third Quarter 2011
3) CB Richard Ellis U.S. Research – Q2 2011 Inland Empire Industrial Market View


Why Basel III Could Do More Harm Than Good

In an effort to prevent banks from becoming over-leveraged and insolvent (as has been seen over the last few years), the new Basel III regulatory regime calls for substantially raised equity requirements, among other changes. However, these changes do not include much needed modification to the mechanisms through which risk is measured. This is cause for concern, given that, in search of higher returns under more stringent regulation, banks will be encouraged to invest available capital in more risky (or toxic) assets.

"Basel III is continuing to enable (and even encourage) banks to take on potentially toxic assets..."

Pablo Triana illustrates this scenario in a recent article of his in the Financial Times. Imagine you have $20bn in equity capital and would like to invest in high-yielding assets. Triana states that before the recent changes, capital charges for “adventurous” (or risky) assets were as low as 1%  of notional value (the total value of a leveraged position’s assets). So, the $20bn of “funky stuff” could cost you just $200m in up-front capital cushion. Those charges will rise with new regulation. However, the increase would remain modest in comparison with trading assets, whose costs could triple in the future. Returning to the scenario, you would only need about $400m to back your risky (and potentially toxic) bet of $20bn. Basel III is, thus, continuing to enable (and even encourage) banks to take on potentially toxic assets by failing to increase the costs associated with taking on risky positions.

Here’s an easy way to think of this effect: one figure banks measure their performance on is return on equity (ROE). The formula for ROE is simply net income divided by shareholder’s equity. When regulations require banks to maintain higher levels of equity, shareholder’s equity (the denominator in the ROE formula) is increased, which decreases ROE. Naturally, banks will seek to maximize ROE in any way possible. With a larger denominator, the numerator must by equally increased to maintain the same ROE. In order to increase net income, banks will seek more high-return, riskier investments.

Essentially, Basel III cracks down on equity requirements without adjusting for the riskiness of a financial institution’s investments, or for the amount of leverage the institution takes on. While the new framework is a much needed attempt to prevent similar scenarios to the crises of 2007 and 2008, it’s failure to account for these essential factors may prove detrimental down the road.

How the ‘Smart Money’ is Influencing Tax Law

It has been the subject of much debate, and even reason for Senators to return to Capitol Hill for a brief work session before continuing campaigning for the midterm elections. I am, of course, referring to the end of the Bush-era tax cuts. With their seats on the line, Democrats are eager to take advantage of this opportunity to win back some favor among constituents.

Wall Street Political Contributions (Dem v Rep)

However, with the legislation that the Democratic majority has pushed through this year, especially the Dodd-Frank Wall Street Reform and Consumer Protection Act, large financial institutions and hedge funds have been sharply shifting financial support from Democrats to Republicans. Dave Levinthal, spokesman for the Center for Responsive Politics commented, “We noticed a very dramatic shift right around the beginning of this year, which coincided with financial reform.” Levinthal sees this as a “major shift in the opposite direction and one that has persisted ever since.”

Here are just a few examples of large banks and investment firms that have participated in political contributions this year:

Citigroup is still partially government-owned, thus it has given equal contributions to Republicans and Democrats this year.

  • Bank of America (NYSE:BAC) is strongly supporting Republicans, with 61% of total contributions made this year. This is a large change from the 2008 elections, where 56% of the bank’s contributions went to Democrats.
  • Morgan Stanley (NYSE:MS) is also favoring Republicans, with 55% of the company’s contributions going to Republicans. Morgan Stanley also favored Democrats in 2008.
  • Citigroup (NYSE:C) appears to be playing it safe by giving equally to Democrats and Republicans (as the federal government still owns a sizable portion of the company). However, in 2008, Citigroup favored Democrats as well, contributing 63% of funds to Democrats.
  • Even Goldman Sachs (NYSE:GS), which has favored Democrats for 20 years, is channeling the majority of its political contributions to Republicans this election cycle.

The question is whether or not the new tax-cut program endorsed by President Obama will help Democrats fare well in the elections this fall. The cuts are, however, namely different from the Bush-era cuts in that they exclude cuts previously available to individuals with over $250,000 in annual taxable income (which really only affects about 3% of Americans). Despite this revision, House Republican Leader John Boehner said Sunday that he’d support an extension of tax cuts for the middle class, even if he couldn’t do the same for wealthier Americans.

President Obama's $50 billion infrastructure improvement plan's aim is to create jobs, something this halted economy needs desperately.

Other forms of economic aid, including a new $30 billion small-business lending fund (details available here), President Obama’s $50 billion infrastructure improvement plan (details available here), and other small-business tax incentives, are all aimed at creating jobs. However, it is clear that, in the end, they do not benefit the “big boys” (or the “smart money”). This is why we continue to see large institutional support for republicans whose political philosophies are more closely aligned with corporate bottom lines.

Whether or not these programs will help Democrats during the elections is yet to be seen. All that is certain is the large role that financial institutions are playing in legislation. Whether this involvement is constructive or detrimental is up for discussion.

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